How to cure a backache

"The backbone of the economy."

This catchy label has stuck firmly to Latvia's small and medium enterprises in the last several months. If that is the case, Latvia must be suffering from severe backaches.

Research sponsored by the Soros Foundation showed that small and medium businesses in Latvia are too few in number (less than 10 per 1,000 residents, compared to about 100 in other European countries), too inactive (60 percent don't show any signs of activity at all after registration), and don't live long (only 30 percent survive to see their fifth year).

These symptoms, if not very commonly known, are easily discovered, and give little indication of why the situation arose and how it can be improved. The three researchers, Valdis Avotins, Janis Birzulis and Edvards Kusners, decided to look for reasons in the Latvian legal system, and found plenty.

An average small business spends many hours of its often brief life filling out forms, figuring out legislative norms, trying to evade taxes and, having done all that, attracting some business.

For the legal system to be favourable to business development, the laws and regulations have to be clear, and the system itself must be stable and predictable, Kusners said.

The Latvian legal system complies to none of these criteria.

Every year Parliament adopts, on average, 250 laws or amendments. And the government, 350 regulations. In addition, government departments draw up numerous instructions on different procedures such as tax collection. Few of the instructions are published, and legal developments are often unpredictable, as the regulations change frequently and sometimes, after a while, come back to where they started, leaving businesses confused and distrustful.

The latter is, perhaps, justified. For, as calculated by the researchers, only 54 percent of changes in Latvian laws had a positive effect on small businesses. One third could be viewed negatively, and the effect of the rest was mixed.

The state has the worst record in the areas where it could help small businesses directly - public procurement and taxation. In public procurement, no tenders or auctions are organized for small orders that could interest small businesses, and government in these cases prefers to deal with the companies with which it has already worked, resulting in discrimination against small companies, many of which have not been in the market for a long time.

Because of the lack of cooperation among government agencies, businesses are also flooded with paperwork. The same documents have to be submitted to several institutions, and officials prefer to refer to businesses, rather than other state departments, for additional information. The researchers calculated that a business spends an average of 10 manhours a month filling in forms.

Much of that time could be spent on more productive activities with improved communications among government departments. SME support policy exists, but the research showed that only a small part of the business community knows of any government initiative to support small enterprises.

This is, perhaps, for the better, since all initiatives are severely underfunded, and are not capable of securing support on a necessary scale. In 1998, the total capacity of all financial support institutions amounted to 8 million lats ($13.3 million), of which 1.2 million lats went for administering these resources.

The only support initiative that reaches all small businesses - a reduced corporate tax rate of 20 percent instead of 25 percent - has little effect, as the study found, on enterprises. Many of them operate at no or very little profit, and do not pay much in corporate taxes. A much heavier burden is social and income tax on employees, on which no discount is provided.

The ways to cure the Latvian backache, as suggested by the researchers, are mostly common- sense.

Small and medium businesses should not be forced to lift and carry heavy taxes; should be provided an opportunity to stretch their muscles by completing government orders; and their interests should be kept in mind when designing new laws or amendments.

At the presentation, Valdis Avotins said he hoped such diagnostic research would be carried out regularly. But diagnosis is not a cure. It is, of course, not up to Soros Foundation to solve the problems they discovered. It is up to the state to put the result of their research to good use.